End of the road for AOFM funds

It seems like a lifetime away but even bankers with a modest memory can recall the boom times in the securitisation markets.

Investment banks such as
Societe Generale
and
ABN AMRO
would spend millions of dollars wining and dining representatives of Australia’s lenders – from
St George
to
FirstMac
– who would jet off to Paris, London, Frankfurt, Barcelona and New York and return with billions in cheap funding.

The money they raised from international investors would be channelled into the buoyant property market as smaller lenders – from building societies to ambitious entrepreneurs with an office and a line of credit – ate into the dominance of the big four banks.

Over $50 billion was raised each year by Australian RMBS issuers from 2004 to 2007. The lending boom created a group of mortgage multimillionaires – including
John Symonds
, Sherman Ma and Allistair Jeffery, Kim Cannon and John Klinghorn – who identified the disconnect in the cheap cost of securitised funding and prevailing standard mortgage rate charged by the big banks.

By May 2007, however, the tide was beginning to turn. Investors had grown nervous about US sub-prime and a collapsing Spanish housing market but that gave Australian borrowers free reign in the funding markets.

ME Bank, BankWest and Suncorp were among Australian lenders that raised $20 billion of RMBS in the second quarter of 2007 but by July issuance came to a screeching halt as investors realised the full extent and consequences of the sub-prime crisis for the securitisation market.

Global appetite shrinks

Faith in mortgage-backed bonds vanished and panicked selling set in. Funding sources that had given Australians infinite access to credit and allowed smaller challengers to snare a share of the multitrillion-dollar home loan market had dried up.

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RAMS Home Loans, which had relied on aggressive short term securitisation financing, was the first to be shut out of the funding markets. Others had more time on the clock, and there was the occasional RMBS raising, but the massive global appetite for securitised bonds had evaporated.

Worse yet - the holders of Aussie RMBS which turned out to be massively leveraged side-carts of the big European investment banks - dumped their Australian paper on the market en masse.

Deep into 2008 it was evident that, with the enormous overhang of Aussie mortgage bonds trading at distressed prices, there was no chance these smaller issuers could raise funds at affordable rates in the capital markets.

It was no less terrifying for the big banks. In the depths of the crisis, panic in funding markets prompted the government to guarantee the deposits and new wholesale debt to all banks – an unprecedented step.

The Labor government also moved to aid smaller lenders reliant on then defunct securitisation markets for financing.

They were starved of funds and desperate to clear their short term “warehouses’ or loans provided by major and investment banks to write home loans.

Life support package announced

In October 2008, Treasury unveiled an initial $8 billion life support package to smaller lenders. The fund would be managed by the Australian Office of Financial Management and would be run by a group of experienced and knowledgable former bankers.

Its objective was to buy primary deals of RMBS by non-major banks with the stated intention of supporting “competition from a diverse range of lenders during the present market dislocation".

The fund immediately got to work and the first institution to source financing was Queensland lender FirstMac which received $500 million of funds. From late 2008 through until 2009, the AOFM committed $7.7 billion of funds and in November 2009, Treasurer Wayne Swan doubled the size committed to $16 billion.

Throughout 2009 Australians continued to meet mortgage payments. Defaults remained fairly low and local investors that hoovered up these securities made a killing but the abundance of cheap RMBS was of little use to lenders that required access to new funding - which the AOFM provided at well below market clearing levels.

In 2010, investment slowed to $4.78 billion; however, the cheap government financing brought issuers that had either exited the mortgage market or never used RMBS as a source of funding to the market.

Macquarie Bank
received a $247 million investment from the office while Australia’s fifth largest lender
ING Group
issued Australian RMBS for the firs time ever via an AOFM-backed offer.

Banking reforms announced

Meanwhile some non-bank lenders that focused on the low documentation loan sector, or Australia’s sub-prime sphere, complained they were not given access to the cheap taxpayer funds.

In December 2010, Swan tabled new banking reforms, including the right to issue covered bond, a huge boon for the major banks. As an apparent concession to smaller lenders, the AOFM program was topped up by another $4 billion.

Into 2011 and nascent demand for residential mortgage-backed bond bonds resurfaced - largely as a result of Australia’s big banks being encouraged to hold RMBS in their liquid portfolios. The bank “balance sheets" became the dominant investors in the market until 2012.

That began to change towards the end off 2012 as falling global bond rates prompted a search for yield among global investment funds. Bank RMBS may not have been the first place they looked but eventually the buying began, driving down borrowing costs.

While the AOFM put its hand up to invest the remaining $5 billion-odd in its kitty in new offers, private appetite was sufficient to replace them and their bids fell away. That prompted Swan’s announcement this week that he would shut down the program.

Net worth of fund

Over the course of its four years the biggest users of the program were ME Bank at $2.1 billion,
Bendigo & Adelaide Bank
at $1.9 billion.
Bank of Queensland
received $1.92 billion while Suncorp had $1.13 billion invested in its mortgage bonds, according to
Westpac
research, Non-bank lenders FirstMac and RESIMAC each tapped the program seven times for $1.64 billion and $1.5 billion respectively, according to Westpac data.

The AOFM program proved vital in keeping the securitisation market’s infrastructure in place by insuring new deals ticked along during the worst of the crisis. For regional banks, AOFM funds helped plug a gap created by their pre-crisis securitisation adventures.

The government also made a modest profit from the program.

Since many of the investments made were at margins well below market prices, the government booked an immediate market loss on many of their investments. However, as loans were paid back by borrowers and credit spreads rallied sharply in 2013 the market-value of these taxpayer investments appreciated to around a break-even level.

The program ensured there was a diversified set of lenders but it could do little to halt the massive market share grab of the big banks. Since 2008 the big four banks’ share of new owner occupied mortgages has grown from around 80 per cent to over 90 per cent. The $15 billion of AOFM funds represented a mere drop in the $1.14 trillion of outstanding housing loans.

The broader question, which Swan would no doubt want to be asked, is whether the big banks’ dominance would be even larger today without the AOFM funds and whether other lenders would be around today to fight for market share in the future without it.